Fraught Pot of Cash at CFPB Stirs Unease

WASHINGTON — A $25 million penalty collected by the Consumer Financial Protection Bureau last month is focusing attention on an aspect of the fledgling agency's powers that was long overlooked but now carries large political significance.

Whenever the bureau collects penalties from firms that violate consumer protection laws, those funds go into what's called the Civil Penalty Fund, which the agency can then use to compensate victims of fraud, as well as to fund consumer education and financial literacy programs.

That specific provision of the Dodd-Frank Act was mostly forgotten during the CFPB's first year in existence, since the agency had yet to impose any penalties. But the fund received its first infusion of cash after the bureau assessed a $25 million penalty to Capital One. The fine is just the opening deposit in what's expected to become a substantial pool of money.

Now the CFPB must decide how to implement the mere two sentences in Dodd-Frank that govern its use of the fund. Its decisions will be closely watched by congressional Republicans who worry that the money will be awarded under contracts with outside consumer groups that are the agency's political allies.

"People will want to know exactly who this money is going to and for what purpose, and why a particular contractor and particular issue was chosen," said Ann Jaedicke, a managing director at Promontory Financial Group.

Among the federal banking agencies, there is no precedent for this type of fund, and so far the CFPB has shed little light on how it will work.

The consumer agency in July released a three-page fact sheet that announced the formation of an internal board to oversee the fund, along with another three-page document that lays out the criteria it will use to award contracts for consumer education and financial literacy programs.

But in response to written questions from American Banker, the agency provided only vague answers to a number of key questions.

For example, the bureau did not give any more detail than Dodd-Frank itself does about how officials will determine when money should go to individuals who suffered harm, and when it should be used for other purposes.

The 2010 law states that the fund "may" be used for consumer education and financial literacy "to the extent that such victims cannot be located" or that payments to them "are otherwise not practicable."

And what will happen in cases like the Capital One settlement, where the victims of the company's violations are expected to receive full compensation without any need to dip into the penalty funds?

The consumer agency again pointed to the language of Dodd-Frank. The law merely states that the money "shall be available, without fiscal year limitation," to pay victims of activities where penalties have been imposed under federal consumer financial laws.

That language might be interpreted to mean that the CFPB can stash away the $25 million from Capital One to compensate victims in future consumer protection cases. But for now the agency is not offering its own interpretation of the law.

The CFPB has good reason to tread carefully, since the Civil Penalty Fund has become a bugaboo for the agency's Republican critics in Congress.

Earlier this year the GOP-controlled House of Representatives voted to repeal the fund. That move followed a December 2011 speech on the Senate floor where GOP Sen. Richard Shelby argued that the fund explains why Democrats have resisted Republican proposals to alter the agency's structure.

"This consumer bureau, as now structured, is allowed to dole out money it collects from fines and penalties to liberal consumer groups," Shelby said in the speech. "This reveals why the administration and the majority want so desperately for the bureau to be unaccountable. They want the bureau to be a permanent funding machine for their political allies."

Shelby doubled down on that argument recently, saying in a statement that CFPB Director Richard Cordray has "unchecked control of this unique slush fund."

No matter what decisions the consumer bureau eventually makes, the Civil Penalty Fund will surely face close scrutiny from Republicans on Capitol Hill.

"If I was Congress, I'd want to know, after it's been up, how much of it has actually gone to victims," said Mark Calabria, a former Shelby aide who is now the director of financial regulation studies at the Cato Institute, a conservative think tank.

"There's going to be real pressure on them to get money out the door," Calabria added. "If they have this sitting around for any significant amount of time, Congress will find a way to use it to pay for something."

As the consumer agency begins to make decisions about the money, perhaps its best guide will be the Securities and Exchange Commission. Under the Sarbanes-Oxley Act of 2002, Congress authorized the SEC to return the penalties it collects to investors who were victimized.

Since then the SEC has collected $10.6 billion in penalties for distribution to victims, of which $9.6 billion have actually gone to the victims, according to the agency.

The $1 billion difference includes taxes owed by the funds, funds not yet paid to investors, money returned to the Treasury Department and administrative costs. An agency spokesperson said the SEC has not analyzed the ratio of payments to victims versus administrative costs.

James Overdahl, a former SEC chief economist, said the agency's process for distributing funds to victims has spawned a small industry of lawyers and consultants who administer the payments.

"I don't think anyone disagrees with the notion of returning money to harmed investors. However, people do worry about the cost, as administering the process can be extremely cumbersome," said Overdahl, who is now vice president at NERA Economic Consulting.

There are a couple of important differences between the processes at the SEC and the consumer bureau. First, at the SEC, money that doesn't go to victims must be returned to the Treasury rather than being sent to outside groups.

Also, the SEC sets up separate funds for victims of different companies — approximately 260 funds have been established over the last decade — whereas the CFPB is establishing a single fund.

Nonetheless, the consumer bureau will face many of the same issues that the SEC has encountered. And it will do so in a more highly charged political environment.

In response to Sen. Shelby's concerns, the consumer agency stated that the fund's governance board was taking steps to ensure that the money is distributed in a transparent and efficient way that protects against waste, fraud and abuse. It also said that it will be transparent about any administrative expenses.

The consumer bureau has yet to sign any contracts for consumer education or financial literacy, but it has stated that the process will be subject to federal contracting requirements.

Whatever decisions the agency makes, lots of eyes will be watching.

"The CFPB over time could collect a substantial amount of money in fines," Jaedicke said. "There is likely to be a lot of money available for consumer literacy and education."